Cost- volume- profit model

1. Constant variable cost and selling price is assumed.2. Only one break-even point,and profit increases as volume increases.3. The diagram is not intended to provide an accurate representation for all levels of output.The objective is to provide an accurate representation of cost and revenue behaviour only within the relevant range of output.

CVP analysis: non-graphical computations

CPY analysis assumptions

1. All other variables remain constant e.g.sales mix, production efficiency, price levels, production methods.2. Complexity-related fixed costs do not change. If the range of items produced increases but volume remains unchanged, then it is assumed fixed costs will not alter.3. Profits are calculated on a variable costing basis.4. Unit variable cost and selling price are constant per unit of output.5. The analysis applies over the relevant range only.6. Costs can be accurately divided into their fixed and variable elements.7. Single product or constant sales mix.

Defining CostsThere are several types of costs to consider when conducting a breakeven analysis, so here's a refresher on the most relevant. Fixed costs: These are costs that are the same regardless of how many items you sell. All start-up costs, such as rent, insurance and computers, are considered fixed costs since you have to make these outlays before you sell your first item. Variable costs: These are recurring costs that you absorb with each unit you sell. For example, if you were operating a greeting card store where you had to buy greeting cards from a stationary company for $1 each, then that dollar represents a variable cost. As your business and sales grow, you can begin appropriating labor and other items as variable costs if it makes sense for your industry.

Setting a PriceThis is critical to your breakeven analysis; you can't calculate likely revenues if you don't know what the unit price will be. Unit price refers to the amount you plan to charge customers to buy a single unit of your product. Psychology of Pricing: Pricing can involve a complicated decision-making process on the part of the consumer, and there is plenty of research on the marketing and psychology of how consumers perceive price. Take the time to review articles on pricing strategy and the psychology of pricing before choosing how to price your product or service. Pricing Methods: There are several different schools of thought on how to treat price when conducting a breakeven analysis. It is a mix of quantitative and qualitative factors. If you've created a brand new, unique product, you should be able to charge a premium price, but if you're entering a competitive industry, you'll have to keep the price in line with the going rate or perhaps even offer a discount to get customers to switch to your company. One common strategy is "cost-based pricing", which calls for figuring out how much it will cost to produce one unit of an item and setting the price to that amount plus a predetermined profit margin. This approach is frowned upon since it allows competitors who can make the product for less than you to easily undercut you on price. Another method, referred to by David G. Bakken of Harris Interactive as "price-based costing" encourages business owners to "start with the price that consumers are willing to pay (when they have competitive alternatives) and whittle down costs to meet that price." That way if you encounter new competition, you can lower your price and still turn a profit. There are always different pricing methods that can be used.

The formula: To conduct your breakeven analysis, take your fixed costs, divided by your price, minus your variable costs. As an equation, this is defined as:

Breakeven Point = Fixed Costs/(Unit Selling Price - Variable Costs)

This calculation will let you know how many units of a product you'll need to sell to break even. Once you've reached that point, you've recovered all costs associated with producing your product (both variable and fixed).

Above the breakeven point, every additional unit sold increases profit by the amount of the unit contribution margin, which is defined as the amount each unit contributes to covering fixed costs and increasing profits. As an equation, this is defined as:Unit Contribution Margin = Sales Price - Variable Costs

How much business you have to generate (either number of products or units of service) in a given time to break even can be calculated using the equation below. You will break even when:Total revenue per month = Total costs per monthUnit sale price Unit sales = Total monthly fixed costs + (Unit variable cost Unit sales)(Unit sale price Unit sales) (Unit variable cost Unit sales) = Total fixed costs(Unit sale price Unit variable cost) Unit sales = Total fixed costsUnit sales per month = Total fixed costs/Unit sale price Unit variable cost